Its a place undefined in time, a location that no one would ever willingly travel to. Are we there yet? The answer is yes. But its going to take 7 to 8 years for the reality to sink in.

Sunday, February 07, 2016

Investment Returns vs Homeownership

The average person thinks that when they pay off the mortgage, they live in their home for free. This is semi correct. Sell the house and put the money in the bank and in the past, the interest was what you would pay to rent the house. So with a half million-dollar home today, the money in the bank pays about .05 percent. That comes out to $2500 a year or $250 a month. Something is wrong here. If you buy the same property as an investment, you will probably get a rental investment return of $2,500 a month which is $30,000. That’s a 6% return on your investment. So being a paid off home owner gives you a better return on your savings than what the bank could offer by a mile.

The statement hidden behind the data is that if interest rates remain low, the average blue collar worker can ill afford the house payments for a very overpriced home. If bank interest rates were to reach 8%, the monthly payment would be $3,660 a month, whereas at 5% they would be $2680 a month. The neat thing about the high sales price, is that it locks in the property tax assessment which is 1% in California. Even at the lower amount, the buyer with no money down needs about 50K a year just for the house payment, taxes and utilities

What is missed here, is that retirement funds or people with cash, can buy a home with an expected rental return of 6%. This in turn puts stress on the starter home prices. They go up in price to a level to where, starter homes are no longer starters.

There is a conundrum here; low bank interest rates, high rental return rates, and unrealistic house valuations. The real loser here is the homebuyer with very little down. He will be broke the rest of his life paying off the home. If you think about it for a few minutes, you will realize that everyone rents the home they live in. Your lifespan determines the rental length. A man in Oxnard made millions leasing 100 acres of land from the city for 100 years. He built rental condominiums on the acreage. After 20 years, he had them paid off and I think he lived to realize another 40 years of income off of them. So after another 40 years, when the lease expires, the relatives will give the land back to the city of Oxnard.

So until the cost of money gets back to more realistic levels. Everyone will be forced to park their savings in real estate investments, not home ownership, there is a difference. This is the definition of a bubble, the miss allocation of resources. The investment return, not the value of the asset, justifies the price paid.

The real reality of the situation is that when the housing prices double, you pretty much double the number of people occupying the house. And it is only noticeable when you come home late and can’t find a parking space for your car. Go figure.

3 comments:

aim
said...

Owning rental properties (income properties) might become one of the most popular investment plans for retirees. 4-6% return on their money will beat most fixed income vehicles. And the risk factor is much lower than corporate bonds, junk bonds or risking your capital in the stock market (where a 10-30% loss could happen over a few days) for 2-3% from dividend payments. As a retiree, I'd feel a lot more comfortable with my nest egg capital in some single family residence homes and/or some four-plexes instead of in a 401k or in a stock/bond portfolio. Let's say one puts their retirement capital of 700k into some income property and gets a 6% annual return of $42,000. Have to be living a pretty frugal life to get by on that. Would have to buy at a very good discounted price for a good return. Would lose 10% of that to property management too if one wanted to be mostly passive as an investor (and avoid the proverbial tenants, trash and toilets hassles). If the income properties were bought for cash flow (not hoping for appreciation) and were free and clear, it wouldn't matter much if property values went down since it is the cash flow you'd be after. The real risk would be government, as usual: raising property taxes, taking away tax exemptions and deductions, putting onerous or burdensome regulations or restrictions on landlords (e.g., rent control), etc. It is a new paradigm for retiring baby boomers. They don't have the nice conditions their retired parents had. Many changes to come.

The wealthy mentality owns rental properties, and the rental income pays the principle, interest, taxes and insurance (PITI) on each property and also give them a positive cash flow or profit after PITI. A portion of the income that they get from rental properties, businesses, stock dividends, bond interest, etc. pays for their personal mortgage, among other things. The poor mentality owns no assets, thus has no real wealth, and works like a slave to pay their mortgage. And the value of their property can drop at any time, putting them underwater. You either collect rent and interest or you pay rent and interest. The wealthy mindset is the American Dream if you ask me.